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Investment Overview for Abercrombie & Fitch Co. (NYSE:ANF)

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Latest Earnings Q1'20

The company reported a rather soft performance for the fiscal first quarter (ending April), with the company falling short of consensus estimates on earnings and revenues. The effects of Covid-19 were clearly evident in the company's performance as revenues plunged by 34% y-o-y $485 million while the company reported a loss of $3.90 per share, as compared to a loss of $0.29 per share in the year-ago period. Abercrombie didn't provide guidance for full-year 2020 due to uncertainty surrounding the impact of Covid-19.

The apparel retailer continues to focus on optimizing its global store network, enhancing its omnichannel capabilities, and growing its loyalty program. These efforts will go a long way in helping the company achieve its 2020 target of a low single-digit sales CAGR, modest gross margin expansion, and doubling its 2017 adjusted EBIT margins. However, the outbreak of coronavirus is likely to have a major impact on the company's business, and it is unlikely that the company would be able to achieve its FY'2020 objectives.

Impact Of COVID-19

Abercrombie stock has lost a bulk of its value since the outbreak of coronavirus. The decline in Abercrombie’s stock is understandable, considering the impact that the outbreak and a broader economic slowdown are likely to have on total consumption/consumer spending and the global apparel industry. Notably, the company derives a bulk of its revenues from the US, which has become the new epicenter of the outbreak- recording the largest numbers of COVID-19 cases across the globe. The company has temporarily shuttered stores outside the Asia-Pacific region, which is likely to impact the company’s performance. Abercrombie also withdrew its earnings guidance provided after the release of its Q4 results (ending January), citing uncertainty relating to the potential impacts of COVID-19 on the company’s business operations.

Store Closures

Since 2010, over 450 stores have been closed, representing more than one-third of the company's store count. Further, a significant number have been remodeled or downsized. In FY 2018, the company closed down 20 A&F stores, in addition to converting 46 Hollister stores and 21 A&F stores into the new prototype format. Moreover, the company closed down further 47 stores in 2019, including the closure of the company’s SoHo Hollister flagship in New York City. Additionally, with an average lease life of 3 years, the company has significant flexibility to find the right store count balance, and drive efficiency by remodeling or resizing the stores, renegotiating leases, or shuttering some. The company is also shifting from large-format and its flagship stores to smaller, mall-based stores. The company noted that over the past two years, the total square footage was down 6%, and ANF saw a steady improvement in overall real estate productivity. In theory, the company's comparable sales should show an improvement when the unprofitable stores are closed down, particularly with a greater focus placed on the online segment. Additionally, the revenue per square foot should increase with stores being downsized.

Direct-To-Consumer Business

A fundamental shift from brick-and-mortar to the online platform is evident, and retail companies have to embrace this trend in order to remain relevant. In this regard, ANF has ensured local and regional fulfillment capabilities across the U.S. and around the globe, as well as supporting 20 websites and 4 apps in 11 local languages. ANF has made a considerable investment of roughly $400 million since 2010, to ensure the growth of its DTC (Direct To Consumer) segment, and has been rewarded as a result. DTC is now its largest storefront, and constitutes roughly 35% of the company's sales volume and represented more than $1 billion in sales volume in FY 2019. Moreover, mobile plays a huge part in digital growth, representing over 80% of the total DTC traffic. To better serve customer needs, ANF has been evolving its omnichannel capabilities and has introduced Venmo as a payment option. Abercrombie's digital store-centric functionalities, such as purchase online, pick up in store, have been driving traffic to stores, consequently spurring purchases and productivity within the store. The company has also introduced reserve-in-store, which enables customers to try before buying; order-in-store, which displays all of the inventory to customers shopping in the stores; and ship-from-store, which enables ANF to optimize its inventory. These efforts should ensure sustained growth in digital sales.

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Hollister Stores' Revenue per Square Foot

Hollister Stores' Revenue per Square Foot: Hollister stores' revenue per square foot declined substantially from $549 in 2012 to $465 in 2015, as a fair portion of consumer spending on basic apparel shifted to fast fashion brands such as Zara and Forever 21. However, this trend has reversed in recent years, with the metric improving to $559 in 2019. Going forward, we expect Hollister stores to continue its recovery, and reach $620 in the long term, thanks to its updated product portfolio. The retailer's efforts to turnaround its product portfolio should help it attract customers in the long run.

Hollister Stores' EBITDA Margin

Hollister Stores' EBITDA Margin: Hollister Stores' EBITDA Margins declined drastically from 14.4% in 2012 to 7.1% in 2019, driven by excessive promotional activities undertaken by the company. However, if Hollister can reduce the pressure on margins, such that they increase to 10% by the end of the forecast period, there could be a 10% upside to our price estimate. Conversely, if margins plummet to 5% instead, there can be an over 12% downside to our price estimate for the company.
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Higher number of Hollister stores than Abercrombie & Fitch stores

Abercrombie & Fitch operates about 308 namesake stores globally, while it has roughly 546 Hollister stores, which are comparatively smaller in size. In the past, Abercrombie & Fitch stores generated better revenue per square foot as compared to Hollister, because it is a relatively expensive brand. This trend reversed in 2017. Consequently, having a significantly higher store count and a better revenue per square foot, Hollister contributes a higher value to the company.

Rapidly growing direct to consumer business

Internet revenues have increased substantially for the company in recent years, forming nearly one-third of the company's sales. The aggressive growth is expected to continue going ahead. With the anticipated growth in online apparel sales in the U.S., Abercrombie's plans to take advantage of this growing segment, and the development of e-commerce channels and an omnichannel portfolio remains a high priority for the company.

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Consolidation of Abercrombie & Fitch stores in the U.S.

Abercrombie & Fitch is looking to reduce its U.S. store fleet to an optimal size, as it takes significant strides towards the development of an omnichannel platform. Also, with its top line under pressure, the company is relying on this strategy to defend its bottom-line growth. Abercrombie & Fitch has closed significantly more stores in the U.S. over the past three years than it has opened.

Since 2010, over 450 stores have been closed, representing more than one-third of the company's store count. Further, a significant number have been remodeled or downsized. In FY 2018, the company closed down 20 A&F stores, in addition to converting 46 Hollister stores and 21 A&F stores into the new prototype format. Moreover, the company closed down further 47 stores in 2019, including the closure of the company’s SoHo Hollister flagship in New York City. Additionally, with an average lease life of 3 years, the company has significant flexibility to find the right store count balance, and drive efficiency by remodeling or resizing the stores, renegotiating leases, or shuttering some. The company is also shifting from large-format and its flagship stores to smaller, mall-based stores. The company noted that over the past two years, the total square footage was down 6%, and ANF saw a steady improvement in overall real estate productivity. In theory, the company's comparable sales should show an improvement when the unprofitable stores are closed down, particularly with a greater focus placed on the online segment. Additionally, the revenue per square foot should increase with stores being downsized.

Re-introduction of Gilly Hicks

Victoria's Secret's loss seems to be A&F's gain. The former discontinued its swimwear line and has suffered from a comps decline ever since. Abercrombie, on the other hand, witnessed aggressive growth in its Swim and Intimates line, with Gilly Hicks continuing to attract new customers to the Hollister brand. The Gilly Hicks brand was relaunched globally at the beginning of 2017 and seems poised for success in the future. As competitor American Eagle's lingerie and activewear brand, Aerie, has been its best-performing segment for a while now, we believe the market has strong growth potential.

Scope For International Growth

While Abercrombie & Fitch has been focusing on right-sizing its store footprint in North America, it is dependent on the international markets for growth through expansion. In Europe, the company sees a $1 billion opportunity across all channels. At present, the company has a modest 129 stores in the region. Consequently, its focus in the region is on increasing penetration, shifting to smaller, more productive stores, and building a more local customer base. The company's partnership with wholesalers, like ASOS, NEXT, and Zalando, should ensure online sales growth. In China, the company estimates a $500 million opportunity. The company currently has only 28 stores in the country and is focusing on growing its digital business, through its partnership with Alibaba, as well as its store count, to address this opportunity.

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We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.

We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

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